Miles To Go.

Depends on how you play the game...

And very little by selling too late, I imagine.

So said legendary financier J.P Morgan, who was an amazing creator of wealth and value. As the market for digital media has heated up, the question of founders and/or angels taking money off the table has heated up as well. There are at least two sides to the story, and I’ve lived them both.

On one side of the argument are the VC’s, who state that they want the Founders committed to building as large a company as possible. They reason that, if a Founder has 99.99% of his net worth in their deal, then his attention is undivided.

On the other side of the argument are the Founders, who’ve pretty much risked everything they have to start the business, or the angels, who risked a lot to grow it. Having cleared the horrible mortality hurdles (95% going toes-up within 36 months), they’ve arrived at a clearing in the Forest of Risk. A sunbeam of liquidity shines upon them, there for a blink of an eye. So its time to pay the mortgage and sock away some tuition with some of the stock, now worth 100x or 1,000x what they paid for it as Founders… or return to the dark Forest of Risk and wait for another sunbeam.

Not surprisingly, the best-known liquidity cases involve some of the hottest Web companies on the planet right now, like the daily deals services LivingSocial and Groupon. Half of LivingSocial’s newest $400 million round was used to purchase employee and early founder shares. Meanwhile, Groupon investors have twice returned money to founding investors and employees, including last April, when Digital Sky Technologies led a $135 million round, and again in January, when Groupon raised a staggering $950 million from eight firms, including DST. Indeed, a filing showed that just $377 million went to the company and that the rest was used for shareholder liquidity. More from PE Hub in an article titled Mercenary or Missionary?

Fred Wilson has written about it (it being a secondary for Etsy in this case) in his AVC column. His Union Square Ventures is one of many firms that have long given their blessing to entrepreneurs once they’ve achieved “something meaningful,” as he says.  Ideally, “meaningful” means “more than [that they’ve just gotten] a product out into the market that lots of people are using but [also] built a business, a team, a revenue model – maybe even become profitable.”

Being both and entrepreneur and an angel, here’s where I come down on the thing: somewhere in between.

Entrepreneurs looking for seed-stage capital and thinking they’lll take 25% of the raise off the table are either selling into a tremendous bubble, sending wild red flags about their commitment, or both. But once a company has developed product, team, revenue and perhaps cash flow, the discussion shifts dramatically.  No sane VC would walk into an LP meeting and say “I have 99% of our investable assets committed to one deal”, so asking entrepreneurs to tell their “Family LP’s” the same thing verges on hypocritical. Entrepreneurs actually become risk averse as their holdings become overweighted, provoking the exact opposite behavior that an investor would want. Likewise, allowing angels to recycle some of their funds allows them to invest in more early stage deals, which feeds the VC dealflow pipe.

Of course, this discussion is moot with 99% of angel investments, because they never get there. But for the lucky few entrepreneurs (and their angels) who build good businesses and have VC’s at the table for a secondary find themselves basking in the warm glow of a liquidity opportunity after a very long hike. It doesn’t last long, and turning back to the forest on an empty stomach can be a very cold, dark experience.

Think it through.